Will the Rate Cut Effect Selling an Investment Property?

After antic­i­pat­ing a min­i­mum of 25 basis points reduc­tion in the FED (Fed­er­al Reserve Sys­tem) funds rate we saw a 50-basis point reduc­tion.  Investors sit­ting with prop­er­ty on the mar­ket for sale are won­der­ing if that will help the real estate mar­ket in any way. 

Sep­tem­ber 18, 2024

By Al DiNi­co­la, AIF®, CEPA™
DST 1031 & OZ Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC Mem­ber of FINRA/SIPC

Buy­ers are also won­der­ing the same ques­tions. The rate cut could have sev­er­al effects on the real estate mar­ket. Buy­ers will typ­i­cal­ly make the first move in deter­min­ing the increase in their pur­chas­ing pow­er.

Sup­ply & Demand

There may be a direct cor­re­la­tion behind a low­er fed funds rate and a decrease in mort­gage bor­row­ing rates. The ques­tion would be how long it takes for the con­sumer rates to drop and how much do they need to drop to increase buy­er demand.  Poten­tial buy­ers may find it eas­i­er to finance the pur­chase. High­er demand may lead to quick­er sales and with more sales there is always the pos­si­bil­i­ty of increased prop­er­ty prices.

 Cost of Buy­er Financ­ing:

Many sell­ers are not inter­est­ed in hold­ing paper (sell­er financ­ing). The rate cut may encour­age buy­ers to move off the side­line and encour­age buy­ers to enter the mar­ket. There may also be an increase in pur­chas­ing pow­er enabling buy­ers to acquire a more expen­sive prop­er­ty. Low­er month­ly pay­ments, espe­cial­ly if pur­chas­ing a rental prop­er­ty may increase cash flow Cash Flow is King.

Investor Inter­est and Impact:

The abil­i­ty to achieve financ­ing may increase investor inter­est. This is a dou­ble-edged sword at times cre­at­ing increased com­pe­ti­tion among poten­tial investor/buyer.

Effects on the Broad­er Mar­ket:

Rate cuts may increase con­sumer con­fi­dence and stim­u­late the econ­o­my and poten­tial­ly increase real estate invest­ments.  Increased bor­der mar­ket sen­ti­ment could make buy­ers more inter­est­ed in acquir­ing prop­er­ty.

Price Sen­si­tiv­i­ty:

Cheap­er bor­row­ing is a rel­a­tive term.  Even with the 0.5% rate, cut some buy­ers may be fix­at­ed upon the rates from a few years ago.  It may be unre­al­is­tic to antic­i­pate a return to inter­est rates under the 3% lev­el. Some buy­ers may still be cau­tious or even pes­simistic about buy­ing now.  How­ev­er, all real estate is con­sid­ered local and there are demand dri­vers in each mar­ket areas.

There are investors con­tem­plat­ing attempt­ing to sell their appre­ci­at­ed invest­ment prop­er­ties via a §1031 exchange who have a few con­sid­er­a­tions. The 0.5% rate cut may have sev­er­al impli­ca­tions, espe­cial­ly if the goal is to take advan­tage of the tax ben­e­fits of the §1031 tax deferred exchange.  Here are a few of the con­sid­er­a­tions.

1. Increased Pur­chas­ing Pow­er

The abil­i­ty for an investor to acquire a more expen­sive prop­er­ty (high­er val­ue) may require a low­er bor­row­ing cost. The require­ments of the 1031 exchange (among oth­ers) are to rein­vest all pro­ceeds into a like kind prop­er­ties. If the investors’ goal is to acquire more expen­sive prop­er­ties, then bor­row­ing at a low­er inter­est rate enables to retire the debt at a low­er rate.

2. Expand­ed Replace­ment Prop­er­ties May be avail­able

One of the chal­lenges for investors exe­cut­ing a 1031 exchange is the abil­i­ty to iden­ti­fy and select a replace­ment prop­er­ty. More investors may be able to enter the mar­ket, albeit poten­tial­ly more com­pe­ti­tion for replace­ment prop­er­ties.  How­ev­er, the reduc­tion in inter­est rate (not nec­es­sar­i­ly cheap) could allow investors to be aggres­sive when seek­ing replace­ment prop­er­ties.  Aggres­sive is defined as offer­ing more for replace­ment prop­er­ties.

3. Future Refi­nanc­ing Post-Exchange

Over the long term (40 years) investors have always looked at refi­nanc­ing to solve a num­ber of chal­lenges.  The refi­nanc­ing could sim­ply be to reduce pay­ments (as rates go down) or to pull equi­ty out of real estate invest­ments. In tra­di­tion­al real estate investors may deter­mine now is the time to acquire anoth­er prop­er­ty with the inten­tion to refi­nance in the future.  Pulling equi­ty out of the replace­ment prop­er­ty post exchange does not trig­ger what may be referred to as a tax­able event. Delaware Statu­to­ry Trust (DST) typ­i­cal­ly does not seek to refi­nance dur­ing the hold­ing peri­od. This requires the spon­sors to struc­ture the real estate asset with sound under­writ­ing.

4. Debt Cov­er­age Ratio

The Debt Cov­er­age Ratio (DCR), also known as the Debt Ser­vice Cov­er­age Ratio (DSCR), is a for­mu­la that rep­re­sents the property’s abil­i­ty to cov­er the debt. Is there enough income to cov­er all the expens­es of the loan.  The net oper­at­ing incomes is divid­ed by the debt ser­vice pay­ment to estab­lish a ratio.  The high­er the ratio the bet­ter and may result in eas­i­er loan approval as well as bet­ter over­all cash flow.

5. Future Invest­ments

The FED has indi­cat­ed that the cur­rent 0.5% cut is a start there is an acknowl­edge­ment that a total of a 1% cut may be being planned by the FED. In the past investors have been con­cerned about ris­ing inter­est rates and the effect on future acqui­si­tions. As soon as the rate cut trick­les down into the mort­gage rates investors may decide to lock in these rates to acquire prop­er­ties.

6. Cap Rate Com­pres­sion

As real estate is local and the mar­ket con­di­tions in one area of the coun­try may be dif­fer­ent than oth­er areas. In prime mar­kets investors will look at cap­i­tal­iza­tion rates (cap rates) may result in cap rate com­pres­sions.  Cap rates have not been com­press­ing over the past few years. If, and it may be a big if in the near future, we see a cap rate com­pres­sion over­all return may be reduced. For the 1031 exchange investors the tax defer­ral may be the dri­ving cause to move now.

7. Eco­nom­ic Sig­nals

The FEDs motives occa­sion­al­ly become the cen­ter of atten­tion.  Was it well times, was if too much, too lit­tle, etc. Ulti­mate­ly it may take the banks to embrace lend­ing to stim­u­late the econ­o­my. Investors may ques­tion if this is an indi­ca­tion that the over­all or broad­er mar­ket con­di­tions and envi­ron­ment are improv­ing or becom­ing less sta­ble. The investor needs to eval­u­ate each invest­ment with risk assess­ment for mar­ket dis­rup­tion in the future.

8. Tim­ing Con­sid­er­a­tions

The stress some investors feel when direct­ly involved in a 1031 exchange with regards to meet­ing the time restraints is evi­dent. The IRS has strict 45-day iden­ti­fi­ca­tion, and 180-day clos­ing are not mov­able. Investors need to iden­ti­fy quick­ly, poten­tial­ly lock in a favor­able rate of financ­ing, and be pre­pared to close. Cur­rent buy­ers (investors) may not view the rate cut increas­ing com­pe­ti­tion for replace­ment prop­er­ties.  That once again may be the dou­ble edge sword. The avail­abil­i­ty of financ­ing does make it eas­i­er to close with­in the time frames.

The mar­ket antic­i­pat­ed a rate cut of 0.25% and it was not a shock for the 0.5% rate cut. Once the rate cut makes its way to the mort­gage rates avail­able to investors it will improve pur­chas­ing pow­er. Bet­ter financ­ing can cre­ate more com­pe­ti­tion. Investors will always keep their eye on over­all yields.

Investor Restric­tion:

DST’s (Delaware Statu­to­ry Trusts) are for accred­it­ed investors only.  Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your 1031 Exchange and com­pli­ment your finan­cial objec­tives. For more infor­ma­tion on how to prop­er­ly set up an IRC 1031Tax Deferred Exchange or if you are an accred­it­ed investor and would like addi­tion­al infor­ma­tion on a DST con­tact Al DiNi­co­la at 239–691-8098 or email adinicola@namcoa.com.

This is not an offer to pur­chase or solic­i­ta­tion to pur­chase any secu­ri­ty, as such be made only through an offer­ing mem­o­ran­dum or prospec­tus.  Invest­ing in secu­ri­ties, real estate, or any invest­ment, in any form, involves risk, includ­ing but not lim­it­ed to the poten­tial of los­ing some or all of your invest­ment dol­lars when you invest in secu­ri­ties. You should review any planned finan­cial trans­ac­tions that may have tax or legal impli­ca­tions with your per­son­al tax or legal advi­sor.   NAMCOA, LLC is a Reg­is­tered Invest­ment Advi­sor, reg­u­lat­ed by SEC (Secu­ri­ties and Exchange Com­mis­sion). Our cor­po­rate office is locat­ed at 999 Van­der­bilt Beach Road, Suite 200, Naples Flori­da 34108. Secu­ri­ties Offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC. 8215 SW Tualatin ‑Sher­wood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed. 

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